When is a charity not a charity? That is the question that has been polarising the voluntary sector throughout the summer. But this is not some esoteric exercise in the modern application of the 1601 Statute of Elizabeth (which still defines charitable purposes in this country). The answer, at least for those opposed to Labour's latest contrivance in public service reform, is simple enough: when it's running a prison.

At the end of June, two respected national charities, Turning Point and Catch 22, announced they had been successful in their bid to build and manage new prisons in London and Merseyside, in a consortium with the private service provider Serco. Last September, the crime prevention charity Nacro revealed it was making a similar bid in partnership with the private security firm Group 4 Securicor, apparently in direct contravention of its stated policy on prison expansion. And this trend is likely to continue, as the government throws its weight behind these voluntary sector/private partnerships as the preferred model for running Britain's increasingly marketised penal system, with five more high-capacity prisons shortly to be tendered.

So what's troubling about a charity bringing its unique expertise and experience to prison management? Nobody would dispute that the voluntary sector already plays a vital role in our jails, with hundreds of organisations providing innovative and inspiring rehabilitation programmes. But prison has another purpose – punishment – and here is where the grand experiment starts to unravel.

Those in favour make the following case: the argument over prison expansion has been lost, in the short term at least. Better to be involved from the get-go in order to ensure these services are delivered as effectively as possible. Thus Catch 22 maintains its commitment to seeing fewer young people incarcerated but, until that happens, considers it more realistic to be where they are. Meanwhile, Turning Point insists its role will mainly relate to resettlement of offenders.

While the impulse is noble, the execution is a tad naive. Though it has not yet made public the precise rung these charities will occupy on the management ladder, as equal partners in a consortium, it seems likely they will be far more involved than before. And this means being party to decisions about security – the use of physical restraint, the treatment of suicide risks, the imposition of virtual solitary confinement – as well as the cuddly stuff like art therapy. Which is surely anathema to their original charitable aims.

This fundamental compromise has a domino effect. How can the public take seriously the penal reform imprecations of a charity bidding to build another prison? How does an offender relate to the rehab work proffered by an organisation he used to think of as independent but is now involved in decisions about his lock-up time? And, as the Howard League's Andrew Neilson points out in this month's Howard Journal, how will certain sections of the media – which seem to drive debate as much as any justice secretary – respond to the first riot at a prison run by woolly liberals? Not only must the charity reconcile its role in rehabilitation and advocacy of prisoners' rights with its new position as keeper of the key chain, but it must also find a way to provide the not-for-profit services it believes in, with a partner focused on profit-making and providing those services at the lowest cost.

This is the real Catch 22. Over the past decade, funding of the voluntary sector has shifted dramatically. It's no longer donations that keep charities in business, but government contracts. Competition is fierce and it's the beefier, more corporate organisations that can front up to the likes of Group 4. And they are also the ones who feel the pressure to participate in private partnerships lest someone get to the cash pot before them. Meanwhile smaller, locally oriented set-ups go to the wall as public philanthropy dips in a recession.

The discourse around charitable governance of prisons can of course appear a bit niche. But the broader question of what charity is really for – to bolster or replace the welfare state? To legitimise privatisation? – is evidently not. By this time next year, in all likelihood, we will have a Conservative government that contends the voluntary sector is best placed to fix all that is broken about Britain. But, as they attempt to smuggle through state shrinkage under the guise of expanding civic society, the New Tories will have crucially misunderstood the current nature of the sector.

It is already predominantly funded by the taxpayer. The big guns that can bid for the big contracts are at risk of becoming quasi-quangos, a new branch of the welfare state without the accountability or legitimacy to match; while the community tin-rattlers so romanticised by Ian Duncan Smith are in serious trouble.

The voluntary sector comes up with some of the freshest and best ideas about tackling society's ills. But it cannot replace the state – indeed, it now relies on it for survival. What a new government needs to examine is why the voluntary sector should be forced to compromise for cash, and make palatable privatisation it doesn't always believe in.